RBI governor YV Reddy is not given to such outbursts. Yet on Monday, three weeks in the run-up to the monetary policy review — a silent period — he made a pointed reference to the role of PE in India. According to Mr Reddy, a significant component of foreign direct investment (FDI) is in the nature of PE or acquisitions of existing firms. What he meant was that foreign money was being poured not into greenfield or new ventures, which is what policymakers would expect out of FDI which ranks right on top of the hierarchy of preferred investment flows.
Although there is no outrage like in the West here, given the incipient nature of PE investment in the country, the figures reflect the concern of India’s financial regulators. In FY07, close to 30% of the total FDI inflows were reckoned to be PE flows through just transfer of shares by locals to foreign funds. In the first three months of this fiscal, estimates are that more than $1 billion has again come into the country through this route. By the end of this fiscal, estimates are that PE flows could top the $13-billion mark.
Yet, regulators have not been able to fully figure out the exact quantum of PE flows into specific sectors. The flows are tracked through banking channels, but so far no distinction has been made in terms of identifying sector-specific PE flows by financial sector regulators. Firms monitoring such flows do not have the full picture, and the central bank may now need to mount an exercise to track such flows closely as the government wants the regulators to do so.
That is where the problem lies. Since a good deal of the money, which comes in as PE, is invested in unlisted firms, Sebi is not in a position to track such flows. Unlisted firms are under the regulatory domain of the ministry of corporate affairs. Ultimately, there is a time lag in capturing this data and also an inability to make a clear distinction regarding the proportion of PE which has been invested in specific sectors. In the absence of such data, policymanagers are hampered in taking pre-emptive action based on their concerns relating to, say for instance, excess flows to the realty sector.
One view is that the onus should be on the banking regulator to keep track of these flows considering that all inflows have to be mandatorily reported by banks. Perhaps, it could help if PE investments were to be reflected in the balance of payments data.
But there is some unease over whether PE should qualify as FDI as it does not result in a lasting interest in the firm in which it invests. Regulators here are not quite sure as to whether PE fund stays invested long enough although they wouldn’t specify the period which qualifies as long term. Their contention is that a good chunk of PE investments are churned enough without any lasting contribution.
This is reflected in the growing outward FDI figures which is almost on par with inflows. During the April-June quarter, outbound FDI accounted for $5 billion, which is almost the same as inbound FDI. The outbound foreign direct investment figures include acquisitions by Indian firms globally, besides capital repatriated by PE when it exits from its investments here.
RBI may have expressed its concerns relating to PE. A test of lasting interest could be in terms of adhering to a longer lock-in for investment. Discouraging such flows could also take the form of more rigorous entry norms or registration. But policy options are limited. Capping such flows or imposing more onerous conditions, such as a longer lock-in period, may hurt investments in small firms, which do not have the comfort of institutional finance or access to the capital markets like their larger counterparts. Besides, there is the signalling effect of any policy retraction to be taken into account.
Policymanagers concede that the distinction between venture capital, PE and other forms of capital is fast blurring. So, plugging one hole may not help.